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The Deep Slush at Bankers Trust

PORING over records at the Bankers Trust Corporation in early 1994, New York State auditors discovered something strange: Millions of dollars in unclaimed customer funds had disappeared.

For two years, the auditors' repeated requests for an explanation were ignored. But they pressed ahead, and what they found left them aghast. The bank, one of the nation's largest, was using the money to inflate its sagging profits.

''They were moving it back and forth between so many other parts of the bank that they lost track of the money,'' said one auditor, who spoke only on condition that his name was not revealed. ''I'd never seen anything on this scale before.''

Bankers Trust, an investment and commercial bank that is the nation's eighth-largest, finally faced the music two months ago. It pleaded guilty in March to criminal charges of illegally diverting $19.1 million in cash and other assets that the law requires to be turned over to states.

Bankers Trust said it uncovered the fraud in 1996 and quickly alerted Federal authorities. In fact, several senior executives learned that the state auditors were asking questions two years before that. And it was pressure from senior executives, Federal prosecutors said, that spawned the fraud in the first place.

Moreover, the extent of the diversion is much greater than has been publicly disclosed, according to individuals investigating the bank. New York State alone has identified more than $41 million owed to it -- more than twice as much as the bank has acknowledged.

And while the bank says its difficulties with unclaimed funds ended in 1996, at least two other states, Georgia and Illinois, are currently examining whether it has shortchanged them since then. An official in Georgia said Bankers Trust had turned over only $663.63 in unclaimed funds between 1996 and 1998, including a check for just $9.08 in 1996. That is so far below the minimum $500,000 that an institution of Bankers Trust's size would ordinarily turn over, he said, that the state has initiated an audit to discover why.

Bankers Trust declined to comment on most aspects of the fraud, citing a continuing Federal investigation that is looking at the roles of former bank executives in the diversion of funds. A spokesman said the company was unaware of audits by other states but would cooperate fully. ''Bankers Trust has worked diligently to cooperate with regulators and law enforcement authorities,'' said the spokesman, William McBride. ''We have strengthened controls to help prevent the recurrence of these problems.''

Bankers Trust has agreed as part of a settlement with Federal and New York State authorities to pay $63.5 million in fines and to return the $19.1 million it acknowledged diverting. But it is not the first bank to run into trouble over unclaimed customer funds. Last year, the Bank of America Corporation agreed to pay $187.5 million to settle California charges that it had mishandled hundreds of millions of dollars over more than 15 years.

Bank of America, which was acquired last year by Nationsbank but retained its name, declined to comment on whether it was currently complying with laws governing unclaimed funds. But nine of the country's other largest banks and trust companies, including Bankers Trust, said they were.

Analysts expect the problems at Bankers Trust and Bank of America to compel regulators to increase their scrutiny of the handling of unclaimed customer funds. Unclaimed funds are bank accounts left dormant for a few years; the money must be turned over to states, which are then responsible for trying to find the owners.

While the Bankers Trust scheme rose to the unusual level of a criminal fraud, huge sums of money owed to consumers, retirees and large public and private institutions may be lying fallow in the vaults of banks and other financial services firms, banking experts say.

''There appears to be a lot of indifference to the issue of unclaimed funds by banks and regulators,'' said Robert Landau, a former Bankers Trust executive who is now a consultant and a leading authority on unclaimed funds. ''But I think they'd be damn fools to keep hiding their heads in the sand now that the problem has come out.''

There was nothing indifferent about the way a humble cast of New York State auditors dug into the books at Bankers Trust. The abuses they uncovered drew the Federal Reserve, the Federal Bureau of Investigation and the United States Attorney's office in Manhattan into the investigation, and they continue to invite scrutiny of a long-overlooked part of the banking business.

A Banker's Climb In a Quiet Corner

Bruce J. Kingdon enjoys all the trappings of wealth. He lives in a handsome, $1.5 million waterfront home in Oceanport, N.J., with a pool in the yard and a BMW and a Lexus in the driveway. He also owns a castle in Ireland and two young thoroughbreds, Crafty Card and Ring by Spring, that he races in New Jersey.

Like his horses, Mr. Kingdon, 48, once occupied the fast track. He joined Bankers Trust in 1982 and became a managing director four years later. In 1993, he was tapped by Eugene B. Shanks, then the bank's president, to run a lucrative unit known as global assets, which oversaw corporate trust accounts, administered pensions and kept an eye on unclaimed funds. Known to acquaintances as B. J., he reported directly to Mr. Shanks and also held a prized seat on the bank's 12-member operating committee.

Mr. Shanks and Charles S. Sanford, the bank's chief executive, had reshaped Bankers Trust during the late 1980's and early 1990's into one of Wall Street's most innovative shops. Once known as just another stodgy corporate lender, Bankers Trust developed an expertise in computer-driven trading and in the creation of newfangled financial hybrids known as derivatives.

Mr. Kingdon's unit was a humdrum corner of this flashy institution, but analysts estimated that it accounted for about 15 percent of Bankers Trust's 1993 profit of $1.1 billion.

In 1994, though, Bankers Trust's highfliers were grounded by scandal. The bank, one of the most loosely managed on Wall Street, came under fire from clients and regulators who accused it of misleading customers about its risky derivative products. Tape recordings, later made public in court hearings, captured the bank's sales force snickering about the naivete of the clients. The fallout was brutal. In just a year, the bank's earnings plummeted to $686 million; a Federal investigation eventually concluded that senior management had suppressed efforts by compliance officers to rein in questionable practices.

Before the Government's investigation was completed, Mr. Shanks and Mr. Sanford, both of whom declined to comment for this article, retired. Frank N. Newman, a former Treasury Department official, was appointed the new chief executive -- a switch engineered by the New York Federal Reserve to help restore the bank's credibility.

But while derivatives were making headlines, trouble was quietly brewing in Mr. Kingdon's domain. It was also in 1994 that three New York state auditors started asking questions about the bank's unclaimed-funds accounts, setting off a chain of events that led to Mr. Kingdon's resignation in early 1997 -- and the bank's guilty plea two months ago.

Within a few days of Mr. Kingdon's resignation, which Mr. Newman at the time attributed to personal reasons, Bankers Trust said it would add $20 million to its reserves to reconcile ''accounting differences'' in the global assets unit.

Federal prosecutors had a harsher term, however, for what went on under Mr. Kingdon's watch. In court papers filed in March, they declared that the bookkeeping irregularities were part of a criminal conspiracy.

The prosecutors said several executives in Mr. Kingdon's unit, whom they declined to identify, treated unclaimed accounts like a vast slush fund. And far from being a rogue operation to fill their own pockets, the prosecutors said in a statement in March, the Bankers Trust scheme was initiated because senior executives ''placed severe pressure'' on underlings to enhance the bank's dismal performance from 1994 to 1996.

According to lawyers and Bankers Trust employees familiar with the Federal investigation, Mr. Kingdon, although not named in court papers, orchestrated the fraud.

Mr. Kingdon, who is the chief target of the Federal investigation, declined repeated requests for an interview. His lawyer, Stanley Arkin, has not disputed Mr. Kingdon's involvement in the scheme, but argues that his client's actions did not amount to a criminal fraud. Laws governing unclaimed funds are murky, Mr. Arkin said, adding that Mr. Kingdon would contest any charges filed against him.

Officials in the United States Attorney's office said that when the bank's management first alerted Federal investigators to the scam, it played down the involvement of Bankers Trust employees.

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In response, Bankers Trust said it minimized its executives' culpability at first because it did not realize the scope of the fraud. What it has not said, however, is that state auditors were pressing it for answers to questions about a possible conspiracy two years before the bank notified Federal authorities.

Auditors at the New York State Comptroller's office -- which audits banks for unclaimed funds originally owned by New York residents or institutions -- are known to be unusually dedicated, yet loath to see their names in print. True to their reputation, none of those involved in the Bankers Trust investigation would comment for attribution.

When the auditors noticed in 1994 that Bankers Trust's unclaimed-funds accounts had dropped from $10.2 million in 1993 to $3.9 million in 1994, they asked for records explaining the plunge. But despite repeated requests, the documents were not forthcoming. Because banks were ordinarily quick to assist them, the auditors were bothered by the fact that Bankers Trust was not.

''The bank initially wasn't very cooperative and indicated that records couldn't be located,'' Comptroller H. Carl McCall said in an interview. Bankers Trust's diversion of unclaimed funds ''is one of the more egregious abuses my auditors have uncovered,'' he added.

Again and again, for more than two years, the auditors were told that the records had been transferred from New York to a warehouse in Nashville. The audit moved ahead slowly, partly because the auditors' resources were stretched thin but also because they failed to use stronger measures available to them, like issuing subpoenas or fining the bank, in the hope that it would cooperate.

Remarkably, even as the state auditors were in the bank raising questions about unclaimed funds, several Bankers Trust executives were blatantly foraging through those same accounts to locate money they could withhold from the state, according to allegations in an unsuccessful civil lawsuit filed in 1996 by Let W. Lee, a managing director who reported to Mr. Kingdon, against Bankers Trust in Federal court in Manhattan.

In the spring of 1995, Mr. Lee asked two of his employees, Harvey Plante and Gerard Callaghan, to identify unclaimed funds that could be kept on the bank's books, according to the lawsuit. The suit said Mr. Lee and Mr. Callaghan directed Mr. Plante to set up a reserve account for unclaimed funds -- the same account that Federal prosecutors would later label a slush fund.

The suit said Mr. Kingdon and Paula C. Gabriele, head of Bankers Trust's retirement services business, knew about the reserve account. It also said Mr. Lee cleared all of his actions, which he believed to be legal, with Bankers Trust's compliance officers. (The bank's compliance officers notify senior management of routine requests like Mr. Lee's only if they believe a problem has arisen, according to a bank spokesman.)

Mr. Lee's suit, which claimed that the bank libeled him in a disclosure to Federal authorities, was dismissed by an appeals court in February, on technical grounds; Bankers Trust was never called upon to respond to its allegations.

In all, Bankers Trust said 13 employees involved in the diversion of unclaimed funds resigned between 1996 and 1997.

Messrs. Kingdon and Plante, along with Kenneth Goglia, a former managing director for financial controls who worked for Mr. Kingdon, have all been formally notified that they are under investigation by Federal authorities, according to lawyers and Bankers Trust employees involved in the matter. Lawyers for Messrs. Goglia, Plante and Lee declined to comment. Ms. Gabriele's lawyer said she was not a target of the investigation and had left the bank on good terms. Mr. Callaghan, also not a target and still employed by Bankers Trust, declined to comment.

Late in 1996, with their paper trail still incomplete, the auditors decided to go over the heads of the Bankers Trust managers with whom they were dealing and to complain to more senior officials. (The auditors declined to identify any of the individuals they spoke with at the bank.)

''Oh, we were just going to call you,'' one of the auditors paraphrased a Bankers Trust senior official as telling the audit team in 1996. ''We realize we have a problem.''

That position struck one of the auditors as odd, since he had been examining the bank for more than two years. Bankers Trust declined to comment on anything having to do with the auditors' activities, including exactly who in the bank's upper ranks knew about the questions the auditors were asking.

In an interview, however, a bank spokesman said Bankers Trust had first heard about problems with unclaimed funds in an exit interview with a departing employee in early 1996 -- more than two years after the state auditors began pestering it for records. The bank said it was the exit interview that caused it to begin an internal investigation of unclaimed funds and to alert Federal authorities to the problem.

A Guilty Plea, But No Closure

In 1997, the state auditors finally demanded access to Bankers Trust's records. One of the auditors took advantage of a business trip to Nashville to make a detour to the records center there. This time, the bank cooperated -- and only then, the auditors said, did they begin to understand the full dimensions of what was happening.

But while they were the first to ferret out the problems at Bankers Trust, they were not the ones who brought the investigation to a head.

After plugging away in 1997 and 1998, the auditors were asked last October by the F.B.I., the Manhattan United States Attorney's office and the Federal Reserve to turn over thousands of pages of documents. A month later, representatives of those agencies met with the auditors and told them they were taking over the investigation.

In March, Bankers Trust pleaded guilty to criminal charges of diverting the funds. Because most companies and investors are forbidden to do business with convicted felons, Bankers Trust's admission could have put the bank out of business had it not already agreed in November 1998 to be acquired by the German banking giant Deutsche Bank A.G.

Bankers Trust informed employees in an internal memo in March that it was working closely with regulators to make sure there was no recurrence of unclaimed-funds problems. But it is not clear that those problems have actually ended.

In Georgia, Larry Griggers, director of the state Department of Revenue, said there were questions about the tiny sum in unclaimed funds turned over by Bankers Trust between 1996 and 1998: ''We feel that it definitely should be larger than that, and we've initiated an audit.''

The cupboards appear to have been bare even longer in Illinois. Over 34 years, the Illinois Department of Financial Institutions said, Bankers Trust has turned over just $2,400 in unclaimed funds. The state said it had begun its own audit of Bankers Trust last summer.

Regulators in Washington, including officials from the Fed and the Comptroller of the Currency's office, say that outright theft of unclaimed funds is rare, and not something that bank customers should worry about. Some state regulators add that ignorance of the law, rather than criminal intent, is often to blame.

David Epstein, a Boston lawyer specializing in abandoned-property law, said the Federal and state governments had already collected about $30 billion in unclaimed funds from banks and other companies -- but that consumers and institutions had yet to claim that money. States can make use of the funds once they receive them, but they must turn over the money whenever a rightful owner steps forward.

Still, no one seems to know how much money remains uncollected from banks. Mr. Landau, the banking consultant, said that while only a small percentage of bonds held by 30 banks he surveyed in 1996 were still unclaimed a year after they had matured, their value ''could be billions.''

Mr. Epstein, however, said unclaimed funds still held by banks ''don't approach the staggering amounts suggested by some.'' But, he added, ''the amounts are quite large.''

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A version of this chronology appears in print on May 30, 1999, on Page 3003001 of the National edition with the headline: The Deep Slush at Bankers Trust. Order Reprints|Today's Paper|Subscribe